Author Archive
Frozen Minds on the Medicare Part B Premium Freeze
This week, Sen. Tom Coburn (R-OK) blocked an attempt by Sen. Max Baucus (D-MT) to move — without a recorded vote or CBO score – H.R. 3631, legislation to freeze Medicare Part B premiums. These premiums are automatically deducted from the Social Security checks of seniors, almost all of whom are enrolled in the Medicare Part B (Supplemental Medical Insurance) program.
Social Security recipients will not receive a COLA increase in their monthly checks beginning January 2010 because inflation between October 2008 and September 2009 was negative. But if Part B premiums increase, the dollar amount of their Social Security checks will decrease beginning in January 2010.
What would happen if the Part B premium were frozen for 2010? Seniors would get a double benefit. First they are gaining from a zero reduction in their Social Security checks even though inflation in 2008-2009 was negative. That means the purchasing power of their Social Security checks will be larger (assuming inflation remains low during the 4th quarter of this year).
On top of that, a frozen Part B premium would provide them with more generous Part B coverage because health care prices became more expensive during 2009 relative to other goods and services.
Senator Coburn’s action in blocking the premium freeze is courageous and correct. In a small but important way, it combats the busting of the federal budget by already generous Medicare Part B benefits that seniors receive — three-quarters of which are funded out of federal general revenues (that is, financed out of taxes paid by younger workers).
Skidmore’s Weak Defense of Social Security
University of Missouri-Kansas City political scientist Max Skidmore recently criticized as “add[ing] nothing” Cal-Berkeley economist Konstantin Magin’s arguments in support of Social Security personal accounts. Let’s examine some of Skidmore’s arguments in favor of the current system:
Magin seems almost to promise guaranteed, risk free returns. Even if this were correct, it is irrelevant. Social Security is not an investment scheme; it offers more than retirement benefits, and its low administrative expenses make it more efficient than any private scheme.
Skidmore’s focus on just administrative costs misrepresents the program’s true costs, which includes distortions in saving and work effort in the economy. The payroll taxes that fund Social Security — to the extent that they are perceived as unrelated to future benefits — reduce worker incentives and, at the same time, Social Security retirement benefits induce workers to exit earlier from the work force. Those effects are well-documented by economists David Wise (Harvard) and Jonathan Gruber (MIT). Tax-financed benefits reduce personal saving (as demonstrated by Harvard’s Martin Feldstein), and the program’s institutional structure — the Trust Fund’s investment restrictions — means the program’s surpluses are not truly saved and invested (as argued by Penn’s Kent Smetters and Stanford’s John Shoven). Thus, overall the program reduces national saving. Those resource costs should be added to obtain a true picture of how costly Social Security is.
It has a mildly redistributive effect: workers who earn less receive a greater portion of their earnings in benefits than do those who earn more.
The redistributive effect is not mild at all when you consider its redistribution from younger and future generations toward older ones. There are any number of measures developed by well-respected economists — such as Alan Auerbach (Berkeley) and Larry Kotlikoff’s (Boston University) generational accounting measures — that document the massive intergenerational redistribution that the program imposes. That redistribution remains hidden because of the cash-flow budget accounting adopted by official scoring agencies. As the program’s shortfalls compel policy adjustments in the future, the true scope of the program’s redistributive force will become obvious — but it will be too late to avoid the negative economic effects of forced higher taxes and smaller benefits for future generations.
Filed under: General; Health, Welfare & Entitlements
Helicopter Paulson
Government equity investment or rescue of the broader (non-financial) economy is a mistake. It will damage economic efficiency in the long-term by diluting the value of private shareholders and reduce incentives for cost cutting and product quality innovations.
Of course, the current focus is not on long-term incentives but on how to shorten and moderate the current economic recession. The constantly changing mix of initiatives from the Treasury suggest:
1. A lack of knowledge/vision about what to do–so they’re throwing money at everything that moves in the hope that something will work. These ex-Goldman Sachs personnel that make up the Paulson team are probably not economists–and certainly not good ones. The majority are probably MBAs with little understanding of how things really work in the economy. They probably have a microeconomic firm-specific orientation and management skills that are unsuited for their current responsibilities. If I’m wrong, I’d be very surprised. If I’m right, it’s showing.
2. An attempt to assuage competing political constituencies and provide benefits to potential future supporters.
3. An attempt to distribute wealth to those people/firms that the next Congress and president won’t support–by tying their hands through government ownership of firms.
4. A deliberate and cynical attempt to damage the economy even more to make life difficult for the Obama administration.
I think # 4 is cynical on my part. But although unlikely, it is not impossible given how polarized the political atmosphere was during the GW Bush presidency.
Broad government involvement in private firms to solve the economic crisis is a dangerous turn. The shareholders in these firms took risks and should bear the consequences of their decisions. If they sink, the economy may recover faster as other businesses are created over time in non-housing and less energy intensive sectors. Supporting existing, inefficient firms run by poor decision makers is likely to prolong the recession because keeping those firms and their managers afloat won’t help to restore market confidence. And, this policy will encourage future investors/managers to take even riskier decisions under expectations of yet another government bailout if they fail. Finally, government debt-financed wealth injections are worsening the nation’s finances–we’re already swimming in huge and unpayable entitlement obligations to a growing number of retirees, disabled, poor, and the sick.
The government purchase of securitized auto loans is probably intended to insure auto company creditors, who would otherwise become bankrupt and prolong the credit-flow freeze. It’s another source of bad assets on bank and non-bank financial firm portfolios that’s contributing to the market failure in that sector. I’m more sympathetic to the original TARP idea than government officials seem to be. That way the government’s involvement in the private sector will be limited and it will remove bad assets from their balance sheets–which are responsible for the pervasive uncertainty among financial market players and is causing the credit freeze. But under TARP, government officials don’t get to choose whom to support–they must buy up assets from whoever is currently holding them–be it domestic or foreign firms, “friends and relatives” or “strangers and enemies.”
Filed under: Finance, Banking & Monetary Policy; General; Government and Politics
Non-Myths about the Financial Crisis
A paper by three Minneapolis Fed economists is making the rounds — disputing any funding crisis for non-financial corporate firms. IMHO, this is a very disingenuous paper. All of these so-called myths are really non-myths. Basically, the paper’s focus on “bank lending” is mistaken. Focusing on total borrowing by non-financial sectors shows the accurate picture.
Myth 1. Bank lending to nonfinancial corporations and individuals has declined sharply.
The financial market crisis is in the non-bank financial sector, not in the banking sector. And the authors say (correctly) that the majority (80 percent) non-financial sector borrowing is not from banks. So why focus on bank lending to the non-financial firms to see if there’s a credit crunch?
Myth 2. Interbank lending is essentially nonexistent.
If that’s not true, so what? (See response to Myth 1.) Banks are more tightly regulated by the Fed (compared to non-bank financial companies by the SEC). So banks did not hold the riskiest mortgage backed securities (although they originated and sequestered such assets in off-balance sheet entities and “adverse selected” the best ones for their own portfolio, selling the rest to non-bank financial and other firms). So, again, the banking sector is not where the financial market crisis occurred — it happened in the non-bank financial sector.
Myth 3. Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
But Federal Reserve Board data on total commercial paper borrowing by non-financial sectors took a huge hit in the 2nd quarter of 2008 (see Flow of Funds, Table F.2 from release Z.1 September 18, 2008, line 3). Thus, it’s not surprising that bank credit to non-financial companies may be increasing: Those companies may be drawing more heavily on their lines of credit with banks because non-bank sources of borrowing are constricted. So, where’s the mystery?
Myth 4. Banks play a large role in channeling funds from savers to borrowers.
Again, non-bank financial (and other) companies supply the overwhelming share of non-financial sector borrowing. And the non-bank financial sector is where the financial market crisis is occurring. So, there IS a funding crisis for non-financial firms. Get with it, Minneapolis Fed!
Filed under: Finance, Banking & Monetary Policy; General
The Blame Game
In the now-heated effort of D.C. policymakers and pundits to afix blame for the current financial mess, some fingers are being pointed at the Federal Reserve. The criticism: the Fed kept interest rates too low in the early 2000s, resulting in a lot of easy money. That money, in turn, created the housing bubble and subsequent collapse, ushering in the financial crisis.
Is this criticism sound?
Figure 1 shows the three-month Treasury Bill rate and the Federal funds rate over the past several years. It indicates that, yes, money was easy in the early 2000s, but not because of the Fed. The Fed was forced to reduce and maintain a low Fed funds rate in response to the market’s high price (and corresponding low interest rate) for short-maturity securities such as 3-month T-Bills.
So why were market rates so low?
Chairman Bernanke has suggested that foreign capital inflows were the true cause of easy money earlier this decade. Figure 2 shows that net international capital inflows surged beginning in 1998 and remained high thereafter. Superficially, the interest rate vs. international capital inflows correlation is not strong enough to clinch his argument. Critics could ask why interest rates did not fall until January 2001. Perhaps the answer would be that a strong U.S. economy and stock market during the late 1990s held up interest rates for a time. But then why did asset markets tank in January 2000, followed by the economy in January 2001? Some folks might respond that the Fed funds rate was unsustainably high during 2000. But we don’t really know the answer as yet.
It’s Not a Pretty Picture
The failure of the bailout plan essentially shows the huge lack of confidence among the public that it would achieve its objectives. It also registers doubt about the government’s ability to implement it successfully.
The impasse shows how blunt fiscal policy is and how inept politicians are in managing the economy. The current set of problems did not arise overnight — they festered in the form of government favoritism toward housing finance companies which overextended their operations and ultimately toppled over. Now, those policies have come full circle to rest at Congress’s doorstep. Problem is, they will soon visit our doorsteps too in the form of a weaker economy.
Now that the bailout proposal has failed, Congress may seek a new approach. More likely, the existing plan will be tweaked to enable passage in a re-vote. But delay and political drama will further sap public confidence in Congress and weaken consumer confidence in the economy.
That may mean a deeper recession and trigger calls for still larger bailouts to salvage the financial sector in the future. But a larger bailout package will also be more dangerous. Larger short-term increases in federal borrowing may destabilize international capital inflows and reduce confidence in the dollar.
Overall, it’s not a pretty picture — but score one for supporters of the free market who insist on allowing market reorganization of the financial sector to continue unimpeded…albeit at high risk to the economy over the next few months.
Filed under: Finance, Banking & Monetary Policy; Government and Politics
When to Worry about Moral Hazard?
In three different, recent op-eds, I’ve read that only during boom times should we worry about moral hazard — the idea that some actor will engage in overly risky behavior because he believes that he’ll be bailed out if the risk goes bad. The most recent op-ed to say this is Charles Goodhart’s, in today’s FT.
OK, I did worry about moral hazard in 1998 when stock prices peaked. And again in 2006 during the housing price boom.
Question: Instead of worrying, when is it time to “do” something about moral hazard?
It seems the answer is never. During boom times, no one asks for government to play Good Samaritan. And during a bust — like now — when there’s opportunity to tell negligent investors to “go swim in the lake,” we’re told, well, the time to worry about moral hazard is during boom times!
That’s another reason to call moral hazard the ”Samaritan’s Dilemma.”
Filed under: Finance, Banking & Monetary Policy; Government and Politics; Tax and Budget Policy
Retirement and Fuel Prices: A Match Made In Heaven?
Get ready for Washington D.C.’s Mall to be filled with seniors in the not-too-distant future.
About 25 percent of seniors depend entirely on Social Security for their consumption. And for two-thirds of them, Social Security makes up the majority of their monthly income. With soaring fuel and food prices, they are beginning to complain about being unable to make ends meet — as in, having to cut down on leisure and travel activities.
The rise in gas, food, and commodity prices is unlikely to be a bubble and won’t ”burst” anytime soon. Furthermore, the Fed’s recent interest rate–cutting binge has promoted a weaker dollar and risks higher future inflation and inflation expectations. That means our itinerant seniors will soon demand a larger inflation adjustment on their monthly checks than allowed by Social Security’s post-retirement benefit formula.
No prizes for guessing whether Congress will capitulate!
Filed under: Health, Welfare & Entitlements; Tax and Budget Policy
Doublespeak in Health Policy Reporting
By all accounts, U.S. spending on health care has been growing much more rapidly than national output. Health statistics–health spending as a share of national output or per person, compared across developed nations–routinely ranks the United States at the top of the list, and statistics on effective health care delivered per dollar spent routinely ranks the United States near the bottom. So news reporters could not miss the clear implication that Americans need to cut health care spending growth and make their health care sector more efficient. If we could reduce spending on unnecessary and low-value health care services, it would go a long way in achieving both objectives.
Now for the doublespeak: Many proponents of Health Savings Accounts (HSA) that can only be accessed under a high-deductible health plan tout the increased role of health care consumers. With larger out-of-pocket spending initially, consumers have greater incentives to eliminate unneeded and costly health services. But success on this count is routinely dismissed in the media as having undesirable side effects–as in today’s Wall Street Journal (HSA Users Find Hassles Amid Savings, May 1, 2008, Personal Journal, page D1):
…average health-insurance costs rose 3.6% in the past two years for employers who offered high-deductible plans, compared with a rise of 7% for employers without such plans.
That’s followed by
Some analysts say much of those employer savings come because many HSA participants tend to forgo care.
Excuse me, but isn’t this exactly how it’s supposed to work?! The language in all such instances usually hints (as does this WSJ report) that the forgone care is valuable and people with HSAs are therefore suffering unduly. Such implied criticism is unjustified unless accompanied with the qualification that the rejected health care services may not be valuable or cost effective.
Indeed, the article later cites a patient with an HSA “fighting” with a doctor about routine physicals and cardiac exams. The doctor wants these exams to be taken regularly, whereas the patient does not because the high-deductible HSA implies larger out-of-pocket payments. In my personal experience, both types of health checkups are most often a waste of time–all they do is separate the patients from their money, which goes to the doctors.
But if many more consumers were to obtain HSAs and economize their health care spending, it would clearly be a problem for the medical profession. And news reporters usually accept, without further questioning, analysts’ comments about unneeded patient suffering because of forgone care. Clearly, wider use of HSAs and better management of consumers’ health care dollars face tremendous hurdles–the medical profession’s self-interest being the biggest one of all. (And I hope my doctor doesn’t read this.)
Filed under: General; Health, Welfare & Entitlements; Tax and Budget Policy
Rebate Folly
I was exploring some old CBO reports for information on dynamic budget scoring and I came across this nugget:
If a tax cut—such as a rebate or a higher standard deduction—does not reduce the tax on income from an extra hour of work, the additional income will create an incentive for people to cut back their working hours and spend more time at home. Not everyone will respond, but some people (especially second workers in a family with one full-time earner) may decide to leave the labor force to care for children or aging parents or to pursue other interests.
We are about to receive a rebate in May this year as part of the economic stimulus that Congress passed in February. I suppose the folks at the CBO would have pointed out that although a rebate may stimulate consumer spending, it is also likely to reduce labor supply. The net impact, therefore, would not necessarily involve any increase in national output but it would certainly induce stronger inflationary pressures—adding fuel to the inflationary fire the Fed’s apparently stoking by cutting interest rates so rapidly. So it’s perhaps not surprising that the dollar’s value took a nosedive during February this year.
Higher rebate-induced debt and higher inflation implies higher future interest rates and, therefore, increased cost of financing consumer and investment spending. Rebate recipients will benefit today, but everyone will lose in the long-term as the economy becomes more sluggish.
Bottom line: Politicians gain by appearing to be doing something – and most of us lose!
Filed under: Finance, Banking & Monetary Policy; General; Government and Politics; Tax and Budget Policy
The Folly of Dismissing the Effects of Entitlements on Fertility
Steve Entin recently wrote in the Wall Street Journal (“The Folly of ‘Family Friendly’ Tax Policy,” April 9, 2008; Page A15): “…proponents of greater family tax credits also claim that society owes families a big child credit because the children will face huge payroll taxes to support childless retirees who never paid to rear the next generation. Another claim is that payroll taxes make it hard for families to afford children, and we need families to have more children to pay for Social Security and Medicare. These arguments don’t wash. Most people have children because they want them, not because the state needs future taxpayers to fund social programs.”
On the 1st claim of the child tax credit proponents: Higher child tax credits today would strengthen the defense against cuts in future benefits by everyone, and especially by childless retirees. But that goes in the wrong direction relative to what’s required–cutting future benefits because they’re not payable, even under today’s high payroll taxes.
On their 2nd claim: If payroll taxes are a hurdle to procreation by young adults, the correct remedy should be to lower them rather than introduce yet another entitlement for young adults in their children’s names — which they would use to extract resources from those children in the future by way of retirement benefits. But today’s high payroll taxes on parents are not for saving and investing for their own future retirements. Those taxes are for paying benefits to today’s retirees under our pay-as-you-go Social Security system. Cutting payroll taxes, therefore, would require today’s retirees, in turn, to accept smaller benefits—which is, of course, a big no-no for proponents of child-tax credits.
According to Mr. Entin, however, both of these claims don’t wash because of the rather tepid idea that people have kids because they want them, not because they (or the state) wants more future taxpayers.
However, according to studies on the potential links between fertility and entitlement spending, (for example, Michele Boldrin’s) it appears that fertility rates correlate negatively with generous government entitlement expenditures across countries. They also correlate negatively with better access to financial markets which enables people to securely transfer purchasing power to old age. So positive fertility seems to reflect, however indirectly, a desire to “save/invest” for the future in the absence of other public and private vehicles of achieving economic security during old age.
The bottom line: Along with its well-established negative impacts on saving/investing and labor supply, unfunded entitlement promises potentially erode yet another pro-growth factor–fertility. An estimate of net benefit promises to current adults under current entitlement policies — compiled from various tables of the latest Social Security and Medicare Trustees’ reports — shows that such underfunding amounts to $44 trillion in present discounted value! That’s a promise of almost $200,000 in today’s dollars of future Social Security and Medicare benefits for each person aged 15 and older today. Why would you, then, work, save, and have children to safeguard your future?
Filed under: General; Health, Welfare & Entitlements; Tax and Budget Policy
The Fed’s “Central Planning” Woes
Given the financial/regulatory system that we have — which is a very important pre-condition — I grant the Fed and Treasury a TEMPORARY “coordinating” role to help tide over the current crisis. However, the initiatives and actions implemented so far appear unlikely to succeed.
I agree only with its role in the Bear buyout by JPMorgan. It is, by nature, a one-time action that does not protect Bear’s shareholders and operators but protects the financial system from unraveling further — similar to it’s actions re: LTCM. Even if it is repeated for another investment bank, it does not raise the issue of moral hazard because no such bank wants to end up like Bear.
However, the Fed’s new and almost direct support of mortgage backed securities through its primary dealers introduces another moral-hazard potential — likely to be a huge problem down the road, and especially because of the interest rate policy it is adopting.
Interest rate cuts are being overdone. Large cuts are continuing the Fed’s past mistakes of introducing greater uncertainty in market participants’ expectations. It is using the wrong (inflation fighting) tool to achieve its goal of systemic stability which has arisen from poorer visibility of asset quality. The added uncertainty will prolong the resolution of current credit/liquidity shortages.
The longer that credit/liquidity problems last, the more likely is the introduction of PERMANENT new financial market regulations — which would hinder efficient operation — in the very function that is key to resolving current credit shortage problems — the generation of price information.
Finally, Prof. Cowen’s recent NYT oped (”It’s Hard to Thaw a Frozen Market“) compares market pricing under capitalist and socialist systems. In brief, the argument is that socialist systems’ poor market pricing abilities appear to be reflected in the current credit-market woes of the American “capitalist” system. This comparison appears misplaced to me. The general U.S. economy may be relatively free and capitalist — but financial and credit markets are not quite so free.
Current credit market problems are not the result of pure and free market operation/competition. We have a fiat currency whose supply and purchasing power is controlled by Fed interest rate policies. And it appears to have made serious mistakes in the process. This involves larger issues of whether asset prices should be objects for setting Fed policy and whether and how the Fed should respond to supply/oil shocks. Fundamentally, however, financial market participants naturally don’t look to “the free” market to set their expectations about the dollar’s future purchasing power. Those expectations are set by a “central planner” — the Fed.
Filed under: General; Regulatory Studies; Tax and Budget Policy
The Spin on Medicaid
The Administration claimed this week that Medicare and Medicaid spending has slowed, but a close look at the overall picture tells a different story. My colleague Michael Cannon has already posted his opinion about Medicare spending. Here’s the low-down on Medicaid.
The official spin:
Medicaid cost projections are once again declining, reflecting … a slowdown in Federal Medicaid spending growth from over 12 percent per year in fiscal year 2000-2002 to 7.2 percent from 2002-2005, down further to 4.6 percent projected for fiscal year 2006-2007.
And the complete story:
Summary budget tables — updated during the release of the Administration’s Mid-Session Review of the Budget this week — indicate that federal Medicaid and SCHIP (State Children’s Health Insurance Program – also a part of Medicaid) outlays would grow from $129 billion in 2001 to $213 billion by 2008. That’s a cumulative (geometric) annual average growth rate of 7.7 percent during the Administration’s full tenure. The nation’s Gross Domestic Product, on the other hand, would grow at a much slower pace — just 5.2 percent per year during the same period.
Much of Medicaid spending growth resulted from the substantial surge in enrollments and benefits per enrollee during the aftermath of the 2001 recession. Medicaid outlays would be expected to surge during recessions but should abate when growth picks up. The latter did not occur during the 1991 and 2001 recession episodes. During the later recession, changes in federal regulations made it easier for states to expand coverage to broader groups and claim federal matching grants against such coverage. And evidence from micro-data surveys indicates that it was not the poorest groups that received most of the latest increases in Medicaid coverage and benefits.
The reasons for the current slower growth in Medicaid spending are the transfer of the fastest growing prescription drug coverage to Medicare and robust economic growth. However, according to the Administration’s projections, faster Medicaid spending growth – at 7-plus percent per year — is projected to resume after 2007.
Providing greater power to states to redesign their programs while persisting with a federal financing mechanism of matching grants (rather than block grants with capped growth) promotes states’ incentives to spend more. That will cause…you guessed it…more spending on our middle-class Medicaid entitlement.
Filed under: General; Government and Politics; Health, Welfare & Entitlements
Sorry, We Can’t ‘Grow’ Our Way out of the Social Security Problem
Many economists and lawmakers — especially conservatives — argue against tax hikes as solutions to entitlement shortfalls, saying the hikes would be counterproductive. According to this argument, higher taxes would retard growth, reduce federal revenues, and worsen entitlement shortfalls.
For example, Stephen Moore in his June 12 Wall Street Journal column “Don’t Know Much About History…” alludes to a presumed beneficial impact of faster (wage) growth on the financial problems of entitlement programs. Unfortunately, that presumption is incorrect, especially as regards Social Security.
The claim that faster wage growth would reduce Social Security’s financial shortfall is an artifact of the standard (but flawed) 75-year-ahead Social Security financial projections that count payroll taxes through that period but ignore benefit obligations those taxes would create beyond the 75th year. The projections make it look as though robust wage growth would shrink the gap between Social Security revenues and obligations. But the picture changes over a longer timeframe.
Filed under: Health, Welfare & Entitlements; Tax and Budget Policy
A Key Reform for Budget Process Reform
Senate Budget Chairman Judd Gregg’s “Stop Over-Spending” (SOS) plan, announced last week aims at reinstating tight fiscal controls — after letting them erode over many years by gutting pay-as-you-go budget rules and pushing through massive supplemental spending outside of the regular budget process.
The proposal includes a line-item veto for the President to cut wasteful spending and a bipartisan commission for devising solutions to entitlement program shortfalls.
Its main focus, however, is to set deficit caps tied to mandatory spending cuts similar to the Gramm-Rudman-Hollings Deficit Control Act from the mid-1980s. That act, however, proved ineffective and had to be revised multiple times.
The key to whether lawmakers are really serious about budget process reform is whether proposed changes are based on short-term deficit measures or forward-looking long-term unfunded obligation measures.
Spending control laws based on short-term budget measures are likely to mislead policymakers into adopting inadequate or inappropriate reforms. Imagine if we were to determine the need for Social Security reform based on its net cash flow today–which is in surplus.
And we’ve been here before–we thought the pay-as-you-go constraints from the Budget Enforcement Act had done their job and turned them off in 2002–only to see a federal spending spree like never before. If adopted (which appears unlikely) SOS may work for a time, but history is likely to repeat itself.
The key to a budget process is the budget measures on which spending constraints are based. Using the same old budget measures will not deliver a new process. It’s time to make fundamental changes by adopting more appropriate fiscal yardsticks. Unless budget measures fully reflect the budget problems that lie ahead and correctly reflect the consequences of policy changes, we will continue to lurch from one reform to the next without making any improvement–at best.
A Tale of Two Accounts
According to a prominent news report today, U.S. household net wealth was $53.8 trillion at the end of the first quarter of 2006. That’s an increase of almost $5 trillion since the same time last year, and four times as much as the nation’s entire output (GDP) for 2005.
The fact that U.S. household net wealth has consistently increased during recent years provides a comforting counterargument against those who bemoan the decline in U.S. saving. That decline, which commenced during the early 1980s, achieved an important milestone recently: U.S. personal saving dipped below zero for the first time in 2005.
Why, then, is household wealth increasing? The simple answer is that our existing assets are becoming more valuable. Those capital gains are not counted in the income base (worker compensation plus asset income) for calculating saving.
Unfortunately, looking just at household wealth provides false comfort. The point is simple: Take the economy-wide account and split it into two parts: the government account and the household account (private firms are owned by households). Looking at just the increase in household net wealth and congratulating ourselves for how rich we are (collectively) misses the 800-lb. gorilla in the room: the government account.
What does that account look like? The recently released annual reports by the Social Security and Medicare trustees suggest that the total unfunded obligations of those two programs alone account for $84 trillion, also an increase of $5 trillion over one year ago. That doesn’t count Medicaid, whose costs are escalating rapidly (for both federal and state governments) and the rest of government operations including the growing costs of homeland security, border control, anti-terror efforts, and wars abroad. Curbing the size of government along these dimensions is clearly crucial to achieving greater wealth. Without this, much of the household wealth will have to be devoted to paying future taxes.
How rich do you feel now?
How Much to Trust the Medicare Trustees’ Projections?
The recently released Medicare Trustees Annual Report [pdf] contains a stark reminder of the Alice in Wonderland nature of Medicare’s financial projections and policy-making. Page 219 of the report carries the chief actuary’s “Statement of Actuarial Opinion.” Its contents should be mandatory reading for those worried about the program’s future. The statement’s second paragraph is reproduced here:
…the Board of Trustees has emphasized the strong likelihood that actual Part B expenditures will exceed the projections under current law, due to further legislative action [emphasis added] to avoid substantial reductions in the Medicare physician fee schedule. While the Part B projections in this report are reasonable in their portrayal of future costs under current law, they are not reasonable as an indication of actual future costs. Current law would require physician fee reductions totaling an estimated 37 percent over the next 9 years—an implausible result.
In other words: Despite Medicare being in a deep financial hole, don’t expect policymakers to stop digging for a while yet.
The funny part is that the actuarial method used in making projections is perfectly legitimate; it makes projections by completely ignoring future policy changes—no matter how likely they are. But the chief actuary is also correct to point out that certain aspects of current Medicare law are ridiculously out of touch with political reality.
Most official budget analysts have thrown a fit whenever I’ve used the words “debt” or “liabilities” to describe current-law Medicare obligations to future retirees. “We don’t ‘owe’ anyone anything because Congress can change current laws!” they’ve protested.
The chief actuary’s statement exposes the hypocrisy: His statement means that we are also obligated to pay future medical providers MORE than current laws stipulate. And, oh, by the way, don’t call that “debt” either because, in this case, Congress can choose NOT to change the laws!
Filed under: General; Health, Welfare & Entitlements; Tax and Budget Policy
Who’s More Myopic?
Here’s a partial view of the range of issues that needs to be scaled in order to constrain the future size of the federal government. In what follows, A = widely appreciated by the public, N = not widely appreciated, and A-N = appreciated by a few.
- Waiting to reform will mean that the median voter will be older — and tend to vote for tax hikes rather than benefit cuts as a solution to entitlement shortfalls (A).
- Waiting to reform entitlements makes the cost of fixing them increase as a percentage of GDP — and last year, we decided to postpone Social Security reform until who knows when. Just for Social Security, each year brings an additional $600 billion in cost (official Social Security Administration estimate). Note, the economy adds only about $450 billion in additional output each year (N).
- When analyzing the merits and demerits of reforms, we do not consider their full cost because we make policies based on short-horizon fiscal measurements — the 10-year cost of prescription drugs, for example (A-N).
- Recently emerged needs for countering terrorism and international nuclear blackmail means the peace dividend has evaporated and cutting other government spending is less viable as a means of releasing resources for entitlement outlay needs (A-N).
- Private saving has declined and remains low (zero percent on personal saving) precisely because of the types of entitlements we have adopted (my finding from past research on why national saving declined in the U.S.). We’re lucky to be able for borrow capital from abroad today, but all such borrowing will have to be repaid with interest — perhaps just when we need to distribute more for retiree support (A-N).
- We just enacted a massive new and irreversible entitlement — Medicare prescription drugs — the constituency for which will grow more solid by the year (A).
Most of these issues ARE known to policymakers and federal budget practitioners within the beltway. In fact, they have been known since the early 1990s. Despite recognizing these problems, Congress has repeatedly settled into postponing action on entitlement reforms.
What does that tell you?
Those who believe that the government should come to the aid of “myopic” individuals who don’t save enough for the future, think again.
The Social Security Side-Step
In describing the contents of the Social Security Trustees’ latest annual report, most reporters have described the changes as “minor.” That impression rests, however, on a comparison of a large number with a gigantic number—the present value of Social Security’s financial shortfall over 75 years to the present value of total payrolls, also projected over the next 75 years.
Note that according to the report, an additional 2 percentage points must be added to payroll tax rates immediately and must be kept in place permanently. That’s unlikely, and precisely because we are describing the shortfall as “no big deal.”
Problem is, the cost escalates the longer we wait. How long would we wait? When it becomes as large as four percentage points? Six? No, if it becomes that large, chances are taxpayers would revolt and the system would have to face benefit cuts.
Benefit cuts? At a time when beneficiaries are more numerous and politically powerful? Unlikely. Then what? Read the rest of this post »
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